What is Total Cost of Ownership (TCO)?
Total Cost of Ownership is a financial indicator that describes the purchase costs and operating costs of an asset (such as a car, a laptop or industrial equipment) over the course of its lifetime.
The best way to understand TCO is by using the “iceberg” analogy. The initial purchase price represents the visible tip of the iceberg.
The part of the iceberg that is hidden under the waterline are ongoing costs, including installation, training, energy consumption, maintenance, repairs, support, upgrades, and disposal costs.
How is TCO calculated?
The most common formula to calculate TCO is the following:
Total Cost of Ownership = Cost of Purchase + Cost of Operation – Resale Value.
For some assets, such as buildings, the cost of purchase is usually 90% of the TCO.
However, for other assets such as cars, the cost of operation might represent 30-40% of the TCO.
For an average European car of €25,000, the 5-year total cost of ownership (TCO) for a car driven 25,000 km per year (125,000 km total) would be approximately €37,000.
The largest factor is depreciation, which is around 65% over five years, wiping €16,000 off the car’s initial value. This means the car’s resale value after 5 years would be €9,000.
Fuel is the next major expense. Assuming an average consumption of 6.0 L/100km and a price of €1.55 per litre, you would spend approximately €11,625 on fuel over a 5 year period.
Other costs include annual insurance (€3,000-4000), maintenance and repairs (around €750/year, totaling €3,750), road taxes (€300/year, totaling €1,500).
Summing these costs (€16,250 + €11,625 + €4,000 + €3,750 + €1,500) gives the estimated TCO, which notably exceeds the car’s original purchase price.
The total cost of ownership then becomes:
Cost of Purchase (€25,000) + Cost of operation (€11,625 + €4,000 + €3,750 + €1,500) – Resale Value (€9,000) = ~€37,000.
From an accounting perspective, the total cost of ownership is divided into:
- Capital Expenditures. These are the €25,000 paid for the car itself.
- Operational Expenditures. The remainder ~€21,000 in operating costs (fuel, insurance, repairs etc.) are classified as operating expenses.
Why is TCO important?
Companies that diligently and accurately calculate the TCO of their assets are more productive and efficient with how they spend their money compared to companies who do not do this.
TCO encourages collaboration between departments
One advantage of calculating TCO is that it encourages collaboration and communication between different company departments.
This is because the process of gathering the data for an accurate TCO calculation requires information from numerous departments: procurement (initial costs), IT support (labor and software costs), accounting (depreciation and interest costs), HR (training costs).
As a result, TCO becomes an organizational tool that breaks down internal barriers and encourages communication between company departments that would be isolated from one another.
TCO helps companies make better budgets
Accurate TCO calculations will help identify and estimate all potential costs associated with an asset. This helps businesses forecast expenditures with greater precision and avoid unexpected expenses.
Better budgeting and cost prediction helps managers and executives make smarter decisions.
This includes everything from vendor selection, when to sell or replace equipment, which assets are too costly, etc.
TCO reduces risk
TCO helps purchasing teams make better purchase decisions by identifying hidden costs associated with different options.
A common mistake made by procurement departments is to focus exclusively on the initial purchase price. This can lead to investing in low quality assets that have expensive operating costs or are just not good enough to complete the required work.
TCO fixes this by identifying the hidden operating costs and including them in the initial price.
What TCO cannot do
TCO is a very useful business concept, but it does have its limitations.
TCO doesn’t take into account employee productivity and satisfaction.
It is very difficult to calculate the financial cost of factors like employee morale and productivity.
For example: computers that are cheap, but slow and unreliable will frustrate employees and limit their efficiency. However, measuring the exact cost of this lost productivity in euros and cents is complex and often subjective.
Likewise, bad software or hardware can lead to significant but hard-to-measure hidden costs as employees develop inefficient workarounds or waste time seeking technical support.
TCO doesn’t measure revenue and Return on Investment (ROI).
TCO analysis does not calculate how much revenue an asset will generate. TCO is one half of the ROI equation, but it is not the complete picture.
An asset with a very high TCO might still be an excellent investment if it enables the company to generate even higher revenues or enter a profitable new market.
Likewise, an asset with the lowest possible TCO might be a poor investment if it fails to meet performance needs and hinders growth.
TCO must be used in conjunction with revenue projections and ROI analysis, not as a substitute for them.
TCO doesn’t measure quality and strategic benefits.
The TCO model is not designed to measure intangible benefits.
It cannot assign a financial benefit to the improved brand image a company might gain from operating a fleet of modern and attractive cars.
It cannot measure the boost in employee satisfaction and retention that comes from providing high-quality, reliable tools.
It also cannot capture the long-term strategic advantage that might be gained by investing in the latest technology, even if that technology has a high initial TCO.
These qualitative factors are critical to strategic business decisions and must be taken into account alongside the purely financial TCO calculation.
How to lower the total cost of ownership
There are multiple methods available to lower the TCO of an asset. Generally, the actual purchase price is the hardest to lower. However, the operational costs associated with an asset are simpler to optimize.
Method 1: Resell old assets
The easiest method to reduce TCO is to diligently sell any outdated assets the company no longer needs, such as cards, laptops, phones, servers, or even furniture.
To go back to our previous example, a €25,000 car requires €21,000 in operating expenses over the course of 5 years. The resell price would be €9,000
If the company resold the vehicle after 5 years the TCO would be €37,000, or €46,000 if they chose to scrap the car, or give it away.
A similar thought process can be applied to any company owned asset.
Cars are the easiest asset to sell, since there is a large second hand market for them that is very active.
Other asset types, such as electronics, can be sold through an employee buyback program. Basically, the employee is given an option to pay a modest fee to purchase their company issued laptop.
It is a situation where both sides win, since the company recovers part of the laptop’s original price, while the employee receives a device they are familiar with and know its service history.
There are even companies specialized in buying and reselling company assets. They have different names, depending on what asset they specialize in:
- Fleet remarketers specialize in purchasing and reselling used cards.
- Office liquidators specialize in furniture.
- ITAD (IT Asset Disposition) specialize in electronics and other hardware.
Method 2: Implement a Device-as-a-Service model
Device-as-a-Service (DaaS) is a device ownership model where businesses procure, manage, and finance their devices (such as laptops or phones) through a subscription instead of purchasing them.
In short, DaaS is a monthly subscription that provides an individual device (such as a laptop or smartphone) plus device management services (acquiring the device, configuring it, repairs, warranty claims etc.) plus a software layer to monitor and manage the device.
A DaaS model lowers the TCO associated with owning and managing devices such as laptops and phones.
A DaaS provider takes on many responsibilities of a company’s IT department, meaning device repairs, warranty claims etc.
This can mean cost savings by avoiding the need of an IT department, or productivity increases since the IT department can focus on more profitable tasks.
We at INKI are one of the biggest Daas providers in Europe and have extensive experience with this.
This DaaS model has greatly helped LEGO, one our clients, to be more agile and cost effective.
Method 3: Asset Standardization
Instead of managing a diverse and complex portfolio of assets, for example, ten different laptop models from five different manufacturers, a business can standardize and use just one or two carefully selected models.
This seemingly simple decision has a cascading effect that dramatically lowers TCO. It simplifies maintenance and repairs, as IT support only needs to be trained on a limited set of hardware.
Standardization significantly reduces the required inventory of spare parts, freeing up capital and storage space.
Standardization also simplifies user training and makes IT support far more efficient, as helpdesk staff can develop deep expertise on the standard models.
Furthermore, standardizing on a single operating system (e.g., all Windows devices or all MacOS devices) simplifies IT management and security protocols.
This approach also enables bulk purchasing, which can provide a good negotiation position to demand better prices from suppliers.
Method 4: Purchase From a Single Supplier
For complex systems or similar asset types (vehicles, electronics, industrial equipment etc.), consolidating procurement by purchasing from a single strategic supplier can bring substantial TCO reductions.
This approach drastically cuts down on administrative costs by reducing the number of invoices to process, contracts to manage, and supplier relationships to maintain.
More importantly, it simplifies critical post-purchase processes. Warranty claims, technical support, and repair procedures are streamlined because there is only one set of processes and one point of contact to deal with, saving significant staff time and reducing confusion.
Building a strong relationship with a single vendor can also lead to better service levels, more favorable terms, and greater negotiating power over the long term.
Method 5: Implement proactive maintenance
Moving from a reactive “fix-it-when-it-breaks” maintenance model to a proactive maintenance model can greatly help lower TCO.
Implementing a scheduled, preventive maintenance program helps identify and repair minor issues before they become critical, costly failures.
This approach greatly reduces unplanned downtime, which is usually the largest hidden cost associated with an asset.
Another major benefit to a preventative maintenance model is that it increases the resale value of an asset.
After all, it’s much easier to resell a car or laptop that looks and works like new, compared to one that has visible defects.
Conclusion
In essence, Total Cost of Ownership (TCO) is a financial indicator that reveals the full “iceberg” of costs associated with an asset, looking far beyond the visible purchase price to include all operational expenses.
By calculating TCO = Cost of Purchase + Cost of Operation – Resale Value, an organization can determine if an asset can ultimately produce more value than its total cost.
However, keep in mind TCO is a forecast and cannot, by itself, calculate an asset’s revenue generation (ROI) or employee productivity benefit.
